So you have decided to start your own business. Starting your own business can be exciting, fun and often times scary. Going at it alone is what you always wanted to do. If you decide to go all by yourself, you could be making one of your first mistakes.
You may be a good baker, toolmaker, stylist, engineer or architect, but you have never run your own business. The setting up of your new business can be very complicated. There are things that you will not know what or how to do. For those things that you do not know how to accomplish, surround yourself with people who can assist you. Your professional team should be chosen at the outset. This team should include a tax advisor/accountant, attorney, insurance agent and banker.
One of the first choices that you have to make is what form of entity to use for your business. When setting up your business, you have several options. Your business can generally be a sole proprietorship, a general partnership, a limited partnership, a C corporation, an S corporation or a limited liability company. Working with your attorney and tax advisor/accountant will aid you in determining which form to choose.
A sole proprietorship is a type of business where you act on your own behalf as the business. All income and expenses are reported on your individual income tax return. The biggest downside of a sole proprietorship is that your personal assets are at risk for all business liabilities.
However if you have little exposure to business liabilities, this may be an appropriate choice of entity. For example, if you have an internet mail order business that requires little investment, a sole proprietorship may be adequate. On the other hand, if you have a high traffic retail store with substantial investments in fixtures and inventory, you may not want to use a sole proprietorship.
When you have a partner, you may want to use a partnership. A general partnership is an agreement between you and one or more partners to run a business. Items of income and expense flow through to you and the other partners to be taxed on your individual income tax returns. Every partner has full authority to act on behalf of the partnership. However, like a sole proprietorship, you and each of your partners have all of your personal assets at risk for company liabilities.
If some of the partners will not be active in the business and want to limit their liability, a limited partnership might be a good choice. A limited partnership is an agreement between two or more partners to run a business in which at least one of you is a general partner and at least one of you is a limited partner. Items of income and expense flow through to you and the other partners to be taxed on your individual income tax returns.
If you are a general partner, you have the full authority to act on behalf of the partnership, but you have unlimited personal liability for partnership debts. As a limited partner on the other hand, your liability is typically limited to the extent of your capital commitments, but you have no authority over the management of the partnership.
You may want to use a corporate form if you and the other shareholders want to have limited liability for most corporate debts. If you are working in the business, you have to be paid a reasonable wage. Any other distributions to the shareholders that are not wages, generally have to be paid as dividends in proportion to the shareholdings.
A C corporation is generally going to be taxed on its income as a separate entity. Except for certain qualified dividends, distributions to you and other shareholders in the form of dividends will usually be taxed again on your individual income tax returns.
An S corporation on the other hand, items of income and expense flow through to you and other shareholders to be taxed on your individual income tax returns. Income distributions to you and the other shareholders in the form of dividends usually have no tax effect since you have already been taxed on the income.
A limited liability company, also called an LLC, is a type of entity which is owned by one or more persons who own membership interests in the LLC. An LLC can be member managed where each member has full authority over the management of the LLC, or manager managed where certain members or others run the LLC.
You and the other members of the LLC can generally choose how the LLC is going to be taxed either as a partnership (or proprietorship if there is only one member), a C corporation or an S corporation. I most often see LLCs taxed as partnerships or proprietorships. If you are going to be taxed as a corporation, it is best to have your business set up as a corporation so that your organizational documents are consistent with the tax treatment.
The choice of business entity is often determined by your tax and business liability situation. If you have other income, it may be advantageous at least initially to have the business taxed at the individual level so you can offset start-up losses against other income. If the company income is not going to be distributed to you and will just be utilized to build the business or you want certain employee benefits, you may want to use a C or S corporation.
You may want to take a class to help you get started with your business. The Economic Development Alliance of St. Clair County is sponsoring the FastTrac New Venture Entrepreneurial Program this spring from April 16 to June 25. This 10-week program is designed to put entrepreneurs on the fast track to opening a new business. Call Rene at 810-982-9511 or James at 810-989-6935 for more information.
You should review your business and tax situation with your attorney and tax advisor to determine the best form of entity that should be utilized for your business. An experienced business attorney should be used to prepare your organizational documents.
By Matthew M. Wallace, CPA, JD
Published edited March 25, 2012 in The Times Herald newspaper, Port Huron, Michigan as: How to succeed in business